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How French private equity creates value

French GPs rely overwhelmingly on organic EBITDA growth to drive value creation, according to an inaugural study of portfolio companies conducted by trade body Afic and EY.

Perhaps counterintuitively given the country's complex relationship with finance, France has yet to experience significant backlash against private equity ownership, unlike in the UK, where several high-profile deals such as Alliance Boots and Four Seasons have repeatedly drawn the ire of the mainstream media and politicians alike.

Nevertheless, local trade body Afic and consultancy EY have decided to tackle misconceptions surrounding the asset class by launching a new study around value creation drivers in portfolio companies. The two organisations set out to replicate EY's ongoing pan-European research project, European PE Exits Study, which for the past 10 years has looked at value creation in the upper-mid-cap and large-cap spaces.

Given French private equity's reliance on the mid-market, Afic and EY instead chose to focus on portfolio companies with turnovers in the €20-500m range for the recently released French study, further narrowing it down to companies where GPs held a majority stake prior to being divested between 2012-2014. From an initial sample of 81 businesses, EY and Afic conducted 57 in-depth interviews with the companies and their exiting shareholders, poring over IRRs and balance sheets to analyse both growth in equity value and variation in net debt levels.

The results are sure to vindicate the industry's long-held claims: far from bleeding businesses dry and relying on risky financial engineering, value creation relies overwhelmingly (74%) on EBITDA growth. The leverage effect accounts for only 13% of the value creation, with the remainder being attributed to the entry/exit multiple differential.

Moreover, French GPs do not appear to be relying on cost-cutting to drive this growth in profitability, with just 80 cents out of every €10 of EBITDA generated by companies in the sample being attributed to such a value driver. Nearly two thirds (63%) of this growth in profits was instead traced back to organic expansion, with around 29% of EBITDA growth attributed to acquisitions.

Looking more closely at organic growth, the main value driver here is a simple uptick in sales on a comparable basis pre- and post-deal (41% of organic EBITDA growth), closely followed by international expansion (38%). The development of new products and services accounts for the remaining 23%.

"We have observed the same characteristics, from the average holding period to the breakdown of value creation drivers. The main factor here remains organic EBITDA growth of the businesses' historical activity" – Laurent Majubert, EY

Could there be a selection bias in that regard, though, given the absence of large-cap portfolio companies from the sample? EY partner Laurent Majubert says the very small number of such transactions on the French market over the sample period could have had a distorting effect on the overall results, and that the French study's results are consistent with those of the large-cap pan-European one: "We have observed the same characteristics, from the average holding period to the breakdown of value creation drivers. The main factor here remains organic EBITDA growth of the businesses' historical activity."

Humble in victory

The results do not surprise Afic president Michel Chabanel. "The study confirms what the industry has known for a long time – one is always wary of empirical research not backing up anecdotal evidence, but this is not the case here," he says. "Private equity is not there to slash costs and saddle businesses with debt. In fact, net debt went down significantly pre- and post-holding period in the sample, from an average of 4.4x EBITDA at entry to 2.5x at the time of exit."

Another group of stakeholders that apparently will not need further convincing are portfolio company employees themselves. According to the study, work councils (which have to be consulted prior to ownership changes for larger businesses under French regulations) approved of private equity ownership in 96% of the cases pre-deal, with this approval rate going up to 98% at the time of exit. This is perhaps not surprising given that the study also concludes that headcount went up by 6% per annum across the sample, with 40% of this being attributed to jobs creation directly related to organic growth.

Although the results are supportive of the industry's long-held convictions, Chabanel does not foresee Afic launching a broad "hearts and minds" campaign to publicise the study: "We will of course use these findings, but only when appropriate based on our discussions with other stakeholders and the regulator. We do not want to go on the offensive and spark controversy, so are not anticipating a wider campaign around the study for the time being."

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